Golden Dangers as Market Becomes Volatile

By Neil Behrmann

London: May 2006. Momentum in the market is driving gold towards $700 an ounce, levels which were last seen in 1980, the year that the metal peaked at $850.

But dealers fear that the market is becoming dangerously volatile and overbought. Although prices could easily break the barrier, they fret that there could be a sharp setback. In a single day towards the end of April, for example, silver, which is attracting considerable speculative interest, plunged 22 per cent, while gold fell by 6 per cent. Both metals have since recovered, mainly because of a sharp decline in the US dollar, but dealers warn that the market is not for grannies and other unsophisticated investors. In less than six weeks gold has surged by around $140 or 26 per cent.

Traditional metals analysts and dealers have in the main been hopelessly wrong in their bullion predictions in the past few years. They have been stymied because they have underestimated the extent of investment demand over and above the speculative trading of managed futures and hedge funds and dealers. Gold bottomed at $255 mid 2001, but the true turning point came on September 11 of that year, when the market began to realize that the awful event would alter the investing landscape. Some six months ahead of the fifth anniversary of September 11, financial and commodity markets remain jittery about worrying geopolitical risks. They range from an Iran nuclear stand off with the US, an Iraq civil war and terrorism in the Middle East and abroad to Russia threatening to use its huge gas resources as blackmail for monopolistic corporate takeovers in Western Europe.

Illustrating the extent of investment, flows into major Gold Exchange Traded Funds, which list like equities and attract institutions, have risen 14.6 million ounces valued at around US10 billion from 350,000 ounces worth around $1.5 billion at the beginning of 2005. Such has been the speculation of hedge funds and commodity trading advisors that the open interest of silver on the New York Commodity Exchange was almost 900 million ounces at the end of April. The net bull positions of large speculators in futures and options was 176 million ounces, while smaller speculators held 129 million ounces. Since October last year, silver has doubled to around $14 an ounce.

Gold’s open interest was 465 million ounces on New York’s Comex, with large speculators holding a net position of 128 million ounces and smaller ones holding 129 million ounces.

Precious metals refiners and dealers report that gold jewellery demand, which accounts for more than 70 per cent of normal annual consumption, has shrunk considerably in the face of much higher and volatile prices. Scrap supplies have risen sharply as Indian and other Asian hoarders are taking advantage of much higher quotes and are trading in their trinkets and bars of gold.

Commodity bulls such as Barclays Capital are saying that prices of gold, copper are well below peaks in inflation adjusted terms. In the end, however, the consumer must be prepared to pay the price and at current price levels, there is definite resistance to gold. This does not mean that the investment bandwagon can’t drive gold through the $700 barrier, dealers say. But those who now want to climb on, need to be aware of the dangers.

Gold prices are now back to highs last seen in 1980 when then as now, speculative and investment demand accelerated and drove the metal to unexpected heights. In 1980, however, the Hunt Brothers, who were Texan oil tycoons, attempted to corner the silver market by buying the metal on the market. The price then surged to a record $50 an ounce and gold rose in sympathy to a peak of $850 an ounce in January 1980 . In subsequent months and years gold and silver tumbled, with gold slumping below $300 an ounce and silver below $4. The main reason is that thousand of people in Asia, Europe and elsewhere queued up and sold their jewellery and silverware. The scrap was refined into bullion and sold on to the market. Supplies were well in excess of jewellery demand and as prices began to fall investors struggled to find buyers.

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